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How China helped fuel rising Canadian household debt Add to ...

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My column this week highlighted the huge disparity between the financial health of Canadian consumers (terrible) and U.S. households (largely deleveraged and ready to spend) but I didn’t get into the reason why the disparity exists: China.

The chart below highlights the tremendous effect of China’s mid-crisis debt explosion on Canadian asset prices. Materials stocks – which made up 40 per cent of the S&P/TSX Composite index at the time – were yanked out of the doldrums as the Middle Kingdom’s monetary expansion grew.

China M2 vs S&P/TSX Materials index

SOURCE: Scott Barlow/Bloomberg

A debt deleveraging process in Canada may be inevitable, but it isn’t necessarily imminent. Gluskin Sheff + Associates Inc. economist David Rosenberg published a report Tuesday noting that by some measures – net worth to income and the debt service ratio, for example – domestic household debt can be sustained.

But, in my opinion, there are two big conditions attached to Mr. Rosenberg’s sanguine outlook on household balance sheets. One, interest rates have to stay low enough to make mortgage payment and other debt-service charges affordable. The other is that China has to maintain enough growth to keep commodity prices high, and to keep struggling resource companies solvent.

I’ve noted previously that resources play a smaller role in the economy than they do in the S&P/TSX Composite. Still, the economic effects of a slower China and weakening commodity prices would be significant, and painful, for Canada. Declining job growth in the resource sectors themselves would only be the tip of the iceberg. The finance industry would be starved of the big checks from its investment banking business, which is dominated by mining and energy companies. And investors themselves would endure a period of flat or even negative returns.

The last six months have seen interest rates climb and China’s economic growth slow, heightening the risk of deleveraging and a slowing domestic economy. A U.S.-style financial crisis is likely not in the cards for us, but the growing economic risks should be taken seriously by Canadian investors and businesses.

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